Crypto enthusiasts have highly anticipated the day when large institutional players will begin trading actively in the crypto world, but the question never asked by these true believers is are crypto exchanges equipped to provide the level of support that major traders expect, based upon their experiences with legacy equity trading systems?
By the last estimate, there are over 250 crypto exchanges, spread across the globe, many of which have only been in business for a few years, but the vast majority of these entities are woefully behind the “legacy” curve, so to speak, and are ill-prepared to meet the demands posed by institutional investors, if and when they do join the fray.
There continue to be highly publicized shortcomings in how most crypto exchanges operate behind their veil of privacy, but one summary of the issues at hand is as follows: “While analysis of wash trading and other manipulative practices across crypto exchanges continues to surface, even the more respected exchanges can flash signs of shortcomings in the crypto market. In terms of institutional coverage, the gap between legacy equity market structure and crypto continues to be a roadblock for institutional investors that require specific fiduciary benchmarks to be met.”
Fiduciaries are already performing their due diligence on major crypto exchanges and finding their performance levels and reports of liquidity to be suspicious. They are conducting their research well before recommending any crypto avenues to their clients, and the early returns of their investigations are revealing a preponderance of “market takers”, rather than “market makers”.
Jeff Dorman, a Wall Street trading veteran at Arca Funds and hoping to expand institutional participation in the crypto space, has already encountered basic concerns during his routine testing: “As fiduciaries of investor capital there are procedures we have to follow from a compliance and regulatory standpoint. From our experience, some exchanges and service providers are more interested in following those rules than others. It doesn’t take much to push these token pairs around across exchanges. Multiple times when you try to execute on an order book that shows depth, the orders either get pulled or the price moves on you. It’s certainly a problem.”
Slippage and execution below stop losses is just one occurrence he tested. Even at an exchange like Kraken, which does have a good reputation for investor support, a simple 10K order of ETH can move the price by 4%. One trader remarked: “We are not talking about poor execution on an illiquid token. We are talking about the most liquid token on the planet and execution on the platform that is nowhere near where other exchanges are executing at the same time. That shows complete lack of liquidity and market makers, and a complete disregard for real investors who believe Kraken is offering best execution.”
In defense of Kraken, it is fully aware of this industry problem and has recently hired five heavyweights from JPMorgan, Citibank, Credit Suisse, and the CME Group, all with decades of experience managing trading desks. They are making headway to build the infrastructure that will attract, rather than repel, institutional investors. Other crypto exchanges need to follow suit, but far too many of them are mired in outright fraud and price manipulation. Hopefully, as the market structure evolves, these miscreants will be driven from the crypto exchange landscape.
Many of these issues have their origins buried deep within the evolutionary path that cryptos have followed, primarily driven by technologists, as opposed to Wall Street grounded interests and the active participation of broker-dealer OTC desks. As a result, the industry may have to play catch or risk being supplanted by exchanges like Bakkt and ErisX, which are being built from the ground floor up to offer the expected operating tools and experiences that institutional players expect.